1031 Exchange Guide for Knoxville Investors
By Justin Sterling, Senior Advisor, NAI Koella | RM Moore
If you own investment real estate in Knoxville or anywhere in East Tennessee, a 1031 exchange can be one of the most useful tools you have. Done correctly, it lets you sell one investment property and buy another while deferring capital gains tax. Done incorrectly, it can trigger the very tax you were trying to defer. This guide walks through the basics so you can have a better conversation with your qualified intermediary, tax advisor and broker.
What is a 1031 exchange?
A 1031 exchange gets its name from Section 1031 of the Internal Revenue Code. It allows an investor to defer recognizing gain when real property held for business or investment is exchanged for other real property of "like kind" that will also be held for business or investment. Since 2018, Section 1031 applies only to real property, not to equipment or other personal property.
"Like kind" is broader than many investors expect. A Knoxville retail strip center can generally be exchanged for a single-tenant net lease building, an industrial property, raw land held for investment, or an apartment complex. What matters is that both the property you sell and the property you buy are held for investment or productive use in a trade or business. A personal residence or property held mainly for resale (such as a fix-and-flip) generally does not qualify.
The two deadlines that matter most
The calendar is where most exchanges succeed or fail. Two deadlines run at the same time, starting the day you close on the property you sell (the relinquished property):
45-day identification period. You have 45 days to identify potential replacement properties in writing, delivered according to the rules (typically to your qualified intermediary).
180-day exchange period. You must close on the replacement property within 180 days of the sale, or by the due date of your tax return (with extensions) for that year, whichever comes first.
These deadlines are not extended for weekends or holidays. Investors who plan to exchange should start looking at replacement properties before they close the sale, not after.
Identification rules
During the 45-day window, most investors use one of these common rules:
Three-property rule: Identify up to three properties of any value.
200% rule: Identify any number of properties, as long as their combined value does not exceed 200% of the value of the property sold.
95% rule: Identify more than that, but you must acquire at least 95% of the value of everything identified.
In a tight market, identifying backups matters. When good properties are scarce, the first choice may not close.
The role of the qualified intermediary
In a typical delayed exchange, you cannot touch the sale proceeds. A qualified intermediary (QI) holds the funds between the sale and the purchase and documents the exchange. If the proceeds pass through your hands, the exchange can fail. Choose your QI before you close the sale, and make sure the exchange documents are part of your closing.
Avoiding "boot"
To defer all of the gain, investors generally aim to buy replacement property of equal or greater value and reinvest all of the net proceeds. Cash taken out, or a reduction in debt that is not replaced with new debt or added cash, is often called "boot" and may be taxable. Your tax advisor can model how much boot, if any, your exchange would create.
Why Knoxville investors use 1031 exchanges
Investors in East Tennessee use exchanges for many reasons:
Trading management for passive income. Moving from a multi-tenant property that needs active management into a single-tenant net lease property.
Repositioning. Selling an older asset and buying a newer one with stronger tenants or a better location.
Diversifying. Exchanging one large property into several smaller ones, or in different markets.
Consolidating. Exchanging several smaller properties into one larger asset.
Estate planning. Many investors use repeated exchanges as part of a long-term plan, which their tax and estate advisors can explain.
Because Knoxville's retail and industrial markets have been tight, finding the right replacement property inside 45 days takes planning. Having a shortlist of net lease and investment opportunities before you list your property can reduce pressure.
A simple 1031 timeline
Talk to your tax advisor and a qualified intermediary before you list.
List and market your relinquished property; start reviewing replacement options.
Engage the QI and include exchange documents in your sale closing.
Identify replacement properties in writing within 45 days.
Complete due diligence and close on the replacement property within 180 days.
Report the exchange on your tax return (IRS Form 8824), with your tax advisor's help.
How Justin Sterling helps
Justin Sterling is a Senior Advisor at NAI Koella | RM Moore in Knoxville. In 20 years, Justin has closed more than 850 transactions and negotiated thousands of deals. He helps investors sell relinquished properties and find net lease and retail replacement properties across East Tennessee and the Southeast, working alongside each client's qualified intermediary and tax advisor.
Frequently asked questions
How long do I have to complete a 1031 exchange?
You have 45 days from the sale to identify replacement properties and 180 days from the sale (or your tax return due date, if earlier) to close.
Can I exchange a Knoxville rental house for a commercial property?
Generally yes, if both are held for investment. Real property held for investment is usually like kind to other investment real property. Confirm your situation with your tax advisor.
Do I need a qualified intermediary?
For a typical delayed exchange, yes. The QI holds the sale proceeds so you never receive them directly.
Can I take some cash out?
You can, but cash received is generally taxable as boot. Your tax advisor can estimate the impact.
Does a 1031 exchange eliminate taxes?
No. It defers capital gains tax and depreciation recapture; it does not eliminate them.
Talk with Justin
Planning a sale or looking for a replacement property in East Tennessee? Call Justin Sterling at (865) 236-1610 or email jsterling@koellamoore.com.
Disclaimer: This article is general information, not tax, legal or financial advice. 1031 exchange rules are complex and depend on your situation. Before you sell or buy, consult a qualified intermediary and a qualified tax advisor or CPA. Justin Sterling and NAI Koella | RM Moore do not provide tax or legal advice.
Comments